Back in February this year, India announced an ambitious rail budget, proposing to invest almost USD 16 billion in rail projects over the coming year.1 Previously, in December 2014, it had further liberalized the sector to permit foreign direct investment of up to 100 per cent across a range of rail assets, including the construction, operation and maintenance of high-speed, suburban and freight corridors, signaling and infrastructure projects and the manufacturing and maintenance of rolling stock.2
What opportunities does this open up for the private sector and more importantly, will the private sector consider the terms and risk allocations in this sector predictable enough to invest or lend?
2. The Vision
The current Indian Government certainly can't be accused of lacking vision. It's proposal to create a 6,500 kilometer 'Golden Quadrilateral', linking Delhi, Mumbai, Chennai and Kolkata, with separate high speed lines proposed to link Mumbai with Delhi and Kolkata are certainly ambitious.
But are they practical and what are their chances of implementation? Answering to parliament last year, the then Rail Minister, Dr. V. S. Gowda responded that of the 674 projects sanctioned over the last 30 years,worth INR 1.5 trillion (approximately USD 25 billion), just 317 had been completed.
The potential costs of high-speed rail are staggering. Current best estimates suggest that the cost of constructing one kilometer of high-speed track would be in the region of USD 16 million to USD 22.4 million.3 By extrapolation, to build 10,000 kilometers of track connecting India's metros could cost up to USD 225 billion. To put that into perspective, it would need expenditure equivalent to 14 years of India's total current rail budget.
Although the railways came early to India, currently, it does not have a single kilometer of high-speed track. Post independent India's track record on expanding the rail network has not been good. In 1947, independent India took over a legacy of 55,000 kilometers of track. By 2011, the country's rail network stood officially at just under 65,000 kilometers, implying that 10,000 kilometers of new track had been added to the system in 64 years since independence.
Compare that to China. In 1947, it had approximately 27,000 kilometers of railway track. Today, it has an estimated 78,000 kilometers of which high-speed track (facilitating rail travel in excess of 200 kilometers per hour) accounts for 16,000 kilometers (which is more than the length of all the rest of the world's high speed train track combined).4
So how did the Chinese do it? Essentially, they funded it through the Chinese Government's economic stimulus program. Technology transfer agreements with foreign manufacturers such as Alstom, Siemens, Bombardier and Kawasaki permitted the construction of the high-speed trains and Chinese engineers essentially back-engineered train components to build their own indigenous trains capable of speeds of up to 380 kilometers per hour. In all, the Chinese Government has committed to spending USD 300 billion to build 25,000 kilometers of high-speed rail network by 2020 (that works out to be approximately USD 12 million per kilometer).5
But it hasn't been plain sailing for the Chinese either: high ticket prices and low ridership raises broad question-marks about the economic future of high speed train travel across vast distances, especially if it is cheaper to fly the same distance in a fraction of the time.
3. Current Plans
Turning to current plans in India, INR 1 billion (USD 16 million) has been earmarked by the Government for the preliminary construction of the proposed 573-kilometer Mumbai to Ahmedabad high-speed line (the "Mumbai-Ahmedabad Line").
In December 2014, the Government of India announced its intention to allow Indian Railways to float tenders for 20 projects worth almost USD 15 billion for private investment.
3.1 The Dedicated Freight Corridors
The World Bank and the Dedicated Freight Corridor Corporation (the "DFCC") announced in December 2014 that it had signed a USD 1.1 billion loan agreement which will finance the 393 kilometer second phase in Uttar Pradesh, part of the 1,800 kilometer eastern dedicated freight corridor from Ludhiana (in the Punjab) to Dankuni (near Kolkata) (the "Eastern Corridor").
The DFCC is a special purpose vehicle incorporated for the planning, construction, operation and maintenance of the Eastern Corridor and the 1,500 kilometer western dedicated freight corridor from Dadri (near Delhi) to Jawaharal Nehru Port, (near Mumbai) (the "Western Corridor").
It is understood that Indian Railways has acquired 91 per cent of the 11 hectares of land necessary to construct the Eastern Corridor and the Western Corridor, requiring a total investment of approximately INR 900 billion (USD 14.4 billion) to construct.
The Western Corridor has been split into 5 sections and according to publically available information, the EPC contract to construct the 626 kilometer section between Rewari (near Jaipur) and Iqbalgarh (on the Rajasthan-Gujarat border) was awarded to a consortium formed by Larsen & Toubro and the Japanese contractor, Sojitz6 and is expected to cost in the region of INR 67 billion (USD 1.1 billion).
It is reported that almost all land relating to the construction of this section of the Western Corridor has been acquired, along with all necessary approvals for construction and it is estimated that the stretch will take 4 years to build.
It is further understood that the DFCC will tender the 322-kilometer stretch linking Iqbalgarh to Vadodara to Sojitz or Mitsui and it is expected to cost in the region of INR 35 billion (USD 560 million).7
The Western Corridor is being funded entirely by the Japanese International Cooperation Agency ("JICA") to the tune of USD 5.68 billion, repayable over 40 years. It is understood that the terms of JICA's financing requires the consortium to be headed by a Japanese company and further, that 30 per cent of the materials for construction need to be sourced from Japan.8
3.2 Rolling Stock
Public private participation in the manufacturing of rolling stock is not new in India and concession agreements have been granted in the past for the construction of freight wagons.9
Current plans on the slate in relation to rolling stock include the proposed USD 240 million coach factory in Kolar in Karnataka (one of the last cabinet approved decisions of the Congress led Government in 2014).
The factory, to be constructed through a joint venture between the Indian Railways and the State of Karnataka, plans to produce 500 passenger coaches a year. Indian Railways currently has an operational fleet of approximately 52,000 coaches, and aims to add an additional 44,000 by 2020.
Other rolling stock projects include a proposed INR 12 billion (USD 194 million) scheme to manufacture 500 multiple unit cars a year in West Bengal and an INR 5.5 billion (USD 90 million) project to manufacture 400 aluminum coaches in Kerala.
3.3 High-Speed Lines
The High Speed Rail Corporation of India Limited was incorporated in October 2013 to consider high-speed rail projects. It is proposed that it will handle pre-feasibility studies, tendering and the award and execution of projects. It is anticipated that these high-speed rail projects will be executed through the public private partnership mode on a design, build, finance, operate and transfer model (the "DBFOT Model").
Two high-speed projects have been identified for public private partnership and foreign investment. The proposed Mumbai-Ahmedabad Line (discussed above) will be executed through either through a DBFOT Model, or otherwise built through inter-governmental agreement.10
The other proposed high-speed line currently identified is the Chennai-Bangalore-Mysore line. A feasibility study being conducted by the engineering arm of China Railways is currently in progress.11
China Rail Corporation is also currently conducting a survey of the proposed 2,000 kilometer Delhi, Bhopal, Nagpur, Hyderabad, Chennai route which is being carried out free of charge. The cost of constructing this line is an estimated USD 32 billion. It should be noted that 12 other consultancy firms have also submitted bids to carry out feasibility studies for the proposed Delhi-Mumbai, Mumbai-Chennai and Chennai-Kolkata high-speed lines.
3.4 Suburban Lines
Suburban projects on the slate include the 50-kilometer Chhatrapati Shivaji Terminus to Panvel line in metropolitan Mumbai, expected to be executed under the DBFOT Model, costing an estimated INR 140 billion (USD 2.25 billion).
4. Public Private Partnership
The lynchpin of any public private partnership (and any DBFOT Model) is the concession agreement between the relevant public sector authority (in this case, the Ministry of Railways) and the private sector entity proposing to execute the project (invariably, a sponsor incorporated, special purpose vehicle ("SPV").
Historically, while India's Planning Commission has recommended and developed model concession agreements for various sectors within the infrastructure market, the Railways Ministry has preferred to approach the issue on a case-by-case basis (inevitably leading to considerable time being required to negotiate and finalize each individual concession agreement).
Currently, a model concession agreement is cooking with the Ministry of Railways and any concession agreement granting the private sector the right to design, build, finance, own, operate and transfer assets will need to fairly allocate risks and rewards between the private sector and the Government.
Firstly, it will need to establish who will collect revenues, which will most certainly be the Indian Railways. Behind the veil of that collection though, the Government will need to ensure that revenues are shared with the SPV to ensure that it will not only meet its cost of financing, but achieve a return on equity too.
Just as important, any concession agreement will need to clarify who owns the asset during the term and (if relevant) how it will be transferred to the Government at the end of the term (and what payments, if any, need to be made).
It should also be clarified to what extent any SPV is required to lease assets belonging to the Government in order to allow it to execute the particular project being contemplated. It should ensure that the terms of those leases are consistent with the term of the concession agreement.
In the event that land acquisition is necessary, the concession agreement clearly needs to allocate that responsibility on the shoulders of the Government and it should be a condition precedent to the effectiveness of the concession (and in any event, it will obviously need to be a condition precedent to the draw down of any debt made available under lender financing).
Of considerable importance to the bankability of any concession agreement will be the allocation of risk for termination events. By that, we mean that it should be clear what happens in the event of a termination of the project as a result of: (1) the Government failing to discharge its obligations; (2) the SPV failing to discharge its obligations; (3) a change-in-law (which would effectively expropriate or nationalize the project); and (4) an event of force majeure.
As a general rule of thumb, termination events should essentially obligate the Government to pay out the SPV a termination sum that should, at a minimum, discharge its debt costs and (depending on the circumstances) provide a return on equity. These clauses are often the most difficult to negotiate and their importance cannot be over stressed in the context of a bankability review by any future lender to the project.
Structuring the conditions precedent for financial closure is often the most crucial aspect of any project as it essentially draws together the multitude of conditions that are necessary for the SPV to satisfy in order to draw down financing and commence construction.
These will differ from project to project, depending on its nature and whether it relates to the construction of track, ancillary facilities such as rolling stations and other assets, or the provision of ancillary services, such as signaling or maintenance.
However, generally, it would be expected to include: (1) a construction type agreement; (2) an operation and maintenance type agreement; (3) sub-contracts in relation to those agreements; (4) performance bonds and parent company guarantees from those contractors who are constructing, operating and maintaining the project being constructed; (5) licenses, permits and consents relating to the construction and operation of the project (including environmental consents); (6) confirmation of land rights vested being vested in the SPV; (7) equity subscription and shareholder agreements in relation to the SPV (and the equity portion of the project to be funded by the sponsors); (8) sponsor support in the event that certain risks taken on by the SPV materialize (committing the sponsors to provide further equity or debt support); (9) Government support (in the event that certain risks taken on by the Ministry of Railways arise) committing the Government to provide financial support to the SPV; (10) the financing documents relating to the provision of loans by lenders and the structuring of that relationship through a common terms agreement and an intercreditor agreement; (11) security documents in relation to the security that the lenders will take over the assets and rights of the SPV; (12) direct agreements granting the lenders the right to suspend termination by the Ministry of Railways or other key project parties in the event that the SPV materially breaches a project agreement; and (13) ancillary corporate conditions precedent such as board and shareholder resolutions of each material project party and legal opinions in relation to the execution and enforceability of the transaction documents in general.
But do the finances stack up? Has the data been thoroughly analyzed? Have the passenger statistics been pulled apart? It's these economic considerations that will essentially determine the success of any project and its importance cannot be over emphasized in infrastructure projects of epic proportions. These concerns are absolutely crucial in negotiating the key terms of the concession, in relation to any user charge payable to the Ministry of Railways and the ability of the SPV to determine fee structures for users. Anticipated ridership levels or throughput volumes (in relation to freight) at various pricing points need to be carefully scrutinized in assessing whether the project will generate enough revenue to pay operating costs, repay debt and other third party costs over the lifetime of the project. Government support should be triggered in the event that various risks such as ridership or utilization does not materialize in accordance with the projected model.
External market risks also need to be considered carefully. In the passenger segment, if rail ticket costs were more than it costs to fly, why would a passenger choose to travel such long distances by train? At what point does the paying capacity of the differentiated customer make the project a financial white elephant?
It's not news to say that India's creaking infrastructure requires urgent modernization if it is to live up to the aspiration of becoming a central hub for global manufacturing and facilitate its long-term economic growth.
Key to that aspiration is the ability to move large numbers of people and goods effectively and efficiently from point-to-point and the ability of the rail network to connect to the very heart of metropolitan centers makes it an invaluable form of transportation.
But the sums required to build India's high-speed rail network are astronomical and it is difficult to see how the private sector can take on that risk without significant support from Government to mitigate those risks that are essentially outside the control of the private sector.
While we are seeing encouraging developments in the construction of India's Western and Eastern Corridors, and there is no shortage of enthusiasm for the vision of the 'Golden Quadrilateral', it can only be achieved through a well thought out concession agreement fairly allocating project related risks. It's only then, perhaps, will we see the light at the end of the proverbial railway tunnel.
2. It is not currently envisaged that the private sector
will be permitted to operate, except possibly in the case of
high-speed rail and the dedicated freight corridors
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